How to Find Companies That Can Adapt and Thrive

05.12.20

Earnings reports have been a godsend in these troubled times. Since Wall Street turned its attention to first-quarter earnings in April, stocks as a whole (as measured by the Wilshire 5000) gained about 11.5%. Within that, the “growthier” indexes like the Nasdaq and Russell 2000 are up more like 16%!

Well, now it’s May – and the reality is, things are going to get a lot bumpier. Once earnings season wraps up in the next week or so, investors will be left with COVID-19 and economic headlines to set the tone.

Until we can reopen the economy, those economic data points are going to look horrific. So, by late May, the overall tone of the market won’t be nearly as good.

What can investors do in that environment? We certainly can’t retreat to bonds, with Treasury yields still in the “bargain basement”…as are many commodities like oil, for that matter.

What we can do is this: Focus on stocks whose management has proved able to adapt to current circumstances…and even thrive. They’re out there! And I devote all my energy in my newsletters like Platinum Growth Club to finding them.

To show you how, let’s turn to the housing market, specifically. It’s a very dramatic example of the opportunities (and pitfalls) right now.

By that, I mean: Some companies are delivering revenue growth and even earnings beats. Many others simply can’t, as shown by the fact that S&P 500 companies are averaging a 13.6% drop in first-quarter earnings and 0.6% revenue growth.

So, it’s all the more impressive when companies like Invitation Homes (INVH), one of my large-cap stocks, more than double their earnings amidst the coronavirus pandemic.

INVH is a unique housing play, based on a portfolio of single-family-home rentals in 17 popular U.S. cities. Its mission statement is “together with you, we make a house a home,” which includes proximity to jobs and good school districts, three-, four- and five-bedroom homes, pet-friendly homes, Smart Home technology, 24/7 emergency maintenance and customer-focused property management.

During this pandemic, that mission also includes payment plans to give its tenants more flexibility. So far, that’s ultimately led to higher resident satisfaction and 95% of residents paying rent in April.

Ultimately, first-quarter earnings of $0.09 per share on $450 million in revenue represented 3.3% annual revenue growth and 125% annual earnings growth. The analyst community was expecting earnings of $0.05 per share and revenue of $443.57 million, so Invitation Homes posted a whopping 80% earnings surprise and a slight revenue surprise.

At least, it was a “surprise” to other people. The signs were already there for this earnings beat, as you can see in INVH’s Report Card in my Portfolio Grader:

Elsewhere in the housing market, mortgage companies are interesting these days, as I’ve noted before.

The Federal Reserve is doing everything it can to keep rates low and stimulate the U.S. economy. With 10-year Treasury bonds (a common benchmark) yielding just 0.70%, mortgages are cheaper for the companies to buy – and easy to sell. After all, mortgage rates are near their all-time low, now averaging 3.54%. That’s a once-in-a-lifetime opportunity for many homebuyers.

They say “there’s no such thing as a free lunch,” though. The ultralow mortgage rates often come with much “tighter” requirements, like higher minimum credit scores. And that’s not just a function of higher demand for the mortgages, either.

One Big Caveat for Mortgage Investors

While some Americans are rushing out to obtain mortgages (often refinances), others find themselves unable to make payments because they’re out of work amid COVID-19 outbreaks.

Naturally, mortgage companies are anxious to see how this will impact their bottom line. Analysts at CoreLogic (CLGX), a real-estate research firm, created a model to predict delinquent payments, based on the possibility that U.S. unemployment will hit 12% this quarter, then stay above 8% for four more quarters.

From that, CoreLogic is expecting that delinquency will peak in the first quarter of 2021, at 5.1%. That’s roughly 3 million borrowers at any given time:

Source: CoreLogic via Forbes

As you see above, CoreLogic’s other, “Pessimistic” model (in blue) shows that the fallout could be much higher than 5% delinquencies.

As of April 30, 3.8 million homeowners (7.3%) were in “forbearance” per the U.S. federal bailout and stimulus bill, the CARES Act. In other words, these nearly 4 million Americans are delaying their mortgage payments until they regain their financial footing.

The bill allows them to do so for up to one year. This is also a point of contention for mortgage servicers, who cannot skip their own payments to the government bondholders backing these mortgages.

Now, if these loans are backed by U.S. housing authorities Fannie Mae or Freddie Mac, their new guidelines only require their servicers to make those payments for four months.

But the bottom line is, mortgage companies will need enough cash reserves to “ride out the storm.” Otherwise, they could be in serious trouble.

This is why you may have seen mortgage stocks selling off since politicians started debating the bailout bill in March:

I’m pleased to report that my choice for the InvestorPlace Best Stocks for 2020 contest, PennyMac Financial Services (PFSI), has begun to recover much more quickly than other peers. The chart above shows the performance gap suffered by Impac Mortgage Holdings (IMH) and New York Mortgage Trust (NYMT).

But, other than that chart, what makes PFSI a better investment now?

Well, take a look at its Report Card in my Portfolio Grader:

Despite everything, PennyMac rates an A on its Quantitative Grade and its Fundamental Score. That includes a “B” for Cash Flow.

NYMT, for example, can’t quite clear that bar, as you see here:

Overall, NYMT is a C-rated “Hold.” But in this bear market, like any other, there are still “Strong Buys” like PFSI. And as others continue to stumble and fall, they’ll gobble up even more investor capital.

Given how many American families are struggling during the pandemic, the key for housing stocks (and many, many others) is a large cash reserve. This allows these companies to survive and continue to thrive, going forward.

My Model Portfolio is all about smart diversification. I always want the best buys, and I’m willing to jettison even my favorite stocks when they don’t fit with the proven strategy I’ve relied on throughout my career.

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